Managing the Crisis: The FDIC and RTC
ExperienceChronological Overview: Chapter One —
Pre-FDIC

On average, more than 600 banks failed each year between 1921 and 1929.
Those failures led to the end of many state deposit insurance programs.
The failed banks were primarily small, rural banks, and people in metropolitan
areas were generally unconcerned. Investors and other businessmen thought
that the failing institutions were weak and badly managed and that those
failures served to strengthen the banking system. A major wave of bank
failures during the last few months of 1930 triggered widespread attempts to
convert
deposits to cash. Confidence in the banking system began to erode, and
bank runs became more common. In all, 1,350 banks suspended operations during
1930. Some simply closed their doors due to financial difficulties, while
others were placed into receivership.

As liquidity pressures eased during the early months of 1931, the number
of bank failures declined sharply. Unfortunately, that decrease was short-lived.
Great Britain abandoned the gold standard in September 1931, and some depositors
feared that other countries might follow suit. Foreigners with bank accounts
in the United States rushed to convert deposits to gold, primarily in the
New York money market. The effect was a liquidity crisis that caused the
failure of 2,293 banks in 1931, or nearly four times the average annual
number of failures during the 1920s. Losses incurred by depositors in 1931
($390.5 million) exceeded losses incurred by depositors for the entire six-year
period between 1921 and 1926 ($383.6 million.)

Congress created the Reconstruction Finance Corporation (RFC) in January
1932, and on February 27, 1932, passed the Glass-Steagall Act. Those two
pieces of legislation led to the beginning of an improvement in the banking
situation. In the months that followed passage of the legislation, both
the number of bank failures and the amount of depositor losses dropped significantly.
Failures during 1932 declined to 1,453, and losses to depositors in that
year were half those of 1931.

During the winter of 1932 and through 1933, banking conditions again deteriorated
rapidly. Although it is probably not possible to point to a single factor
that caused the calamitous events of that period, general uncertainty with
respect to monetary and banking conditions undoubtedly played a major role.
In states that had declared bank moratoriums, banks accelerated withdrawals
from correspondents in an attempt to strengthen their positions. Currency
holdings increased significantly, partially in anticipation of additional
bank moratoriums.

Franklin D. Roosevelt was elected president in November 1932,
and rumors circulated that his administration would devalue the dollar. Concerns
about the future of the dollar created even greater liquidity pressures. Banks
increased speculative holdings of foreign currencies, gold, and gold
certificates.
That period was unlike the one a year earlier of international monetary
instability and conversion of foreign deposits to gold caused by Great
Britain’s
abandonment of the gold standard. This time many of the conversions
to gold from deposits and Federal Reserve Notes came from domestic sources.
Those
demands placed considerable strain on New York City banks and, ultimately,
on the Federal Reserve Bank of New York.

Sudden withdrawal demands in certain parts of the country started a panic
of massive proportions. State after state declared bank holidays.1- The
panic reached a peak during the first three days of March 1933 following
the failure of an estimated 4,000 banks so far that year. As one of his
first official acts, President Roosevelt proclaimed a nationwide bank holiday
beginning on March 6, 1933, which lasted four days. The financial system
was on the verge of collapse, and both the manufacturing and agricultural
sectors were operating at a fraction of capacity. Administration officials
quickly began to draft legislation designed to resolve the banking crisis.

The Emergency Banking Act legalized the national bank holiday
and set standards for the reopening of banks after the holiday. That act
expanded the
RFC’s
powers as a means to deal with the crisis then threatening the banking
system. It authorized the RFC to invest in the preferred stock and capital
notes
of banks and to make secured loans to individual banks. The President
subsequently issued a proclamation extending the holiday in order to allow
time for officials
to reopen the banks. Several hundred banks soon reopened for business.
As the reopenings proceeded, public confidence increased significantly and
widespread hoarding ceased.

President Roosevelt signed the Banking Act of 1933 on June 16 of that year.
Section 8 of that legislation amended the Federal Reserve Act to create
the Federal Deposit Insurance Corporation. A temporary plan for deposit
insurance began for 13,201 banks on January 1, 1934, with coverage of deposits
up to $2,500. Coverage was increased on July 1, 1934, to $5,000 for each
depositor in an insured institution.

The Banking Act of 1935 terminated the temporary federal deposit insurance
plan and inaugurated a permanent plan. It revised the entire deposit insurance
law and made substantial changes in the plan for deposit insurance originally
enacted on June 16, 1933. Table 1.1 shows all commercial bank suspensions
from 1921 through 1933.